Cheers

Thanks

As Kiashu says, a lot depends on the details. But this of course holds for both a carbon tax and an ETS. By limiting the breadth, making arbitrary exclusions of various industry, or enacting complex regulation, both carbon tax schemes and emissions trading schemes can be weakened.

The point has also been made as to whether the government would be able to resist turning any scheme (tax or ETS) into a simple money-making enterprise. Personally, while I can be as cynical as the best of them, I tend to hold onto the hope that politicians are looking for a good outcome, just like the rest of us. (I could be in the minority in this view!)

Failing that, of course, is the concept of a global treaty. Kyoto, for instance, did put binding commitments on its signatories. Assuming its successor does the same, this will help ensure that Government does the right thing and continue to bring down emissions – using the scheme that has been put in place, be that taxes or an ETS.

The two advantages that an ETS will bring where global obligations are concerned are:

– The ability of an ETS to set a firm ceiling on the _amount_ of emissions (as required by a treaty), and
– The ability of an ETS to allow trading between countries. This will both allow the global community to focus their effort where it can have the most impact as well as encouraging countries to do beat their targets – in a global scheme, if you have permits left over, you could conceivably sell them to other countries that weren’t so well prepared.

The debate between carbon taxes and ETS is a complex one, and I’m not even going to pretend that I’m that well qualified to get into it. Rather than keep stretching this page out, with a discussion on the details, we might leave it there. I think its fair to say that both have their plusses and minuses – maybe the discussion above will get readers thinking.

Again, the number of permits x market price point where profit is maximised can’t be predicted ahead of time. As I said, we live in a world where George’s at $50 a plate and McD’s at $5 a meal can happily co-exist, each feeding us a single meal. But McD’s is high volume, low price, and George’s low volume, high price. So exactly what number the government will have an incentive to sell we can’t know. If the price rises companies may start screaming and demand more permits be sold next year, and if the price is high, the government will be tempted to sell more.

That’s basic economic theory – high demand makes high price which stimulates higher supply. With actual physical products there are limits to how much you can produce; but there are no limits to virtual products like mp3s and carbon permits.

Of course, they could reduce permits and increase prices, but this is contrary to the experience of everyone who ever produced anything. If you own a restaurant and get 120 customers willing to pay $50 a plate, and another 50 customers who want to come but there are no tables for them, do you (a) keep 120 seats and raise it to $60 a plate, or (b) add 50 seats and keep it at $50 a plate? The answer is almost always (b). Increase volume in response to higher demand. The only reason not to is if you can’t. Absent some international treaty, nothing prevents making more permits.

And again, what’s not being addressed is emissions other than fossil fuel burning.

A carbon tax would be more equitable and effective, and wouldn’t contain an incentive to increase emissions.

So I think there is one misunderstanding here with regards to an ETS. An ETS permit does _not_ give the right to emit, or be responsible for, one tonne of CO2 for ever and ever. Rather, the permit is “one use”. If you need to emit 1 tonne of CO2, you buy the permit, you emit the tonne, and the permit is used up. If you want to emit a tonne of CO2 next year, you have to buy another permit.

What this means is that the government gets to issue permits “fresh” each year. So they have an ongoing revenue stream, just like with a carbon tax. To use your example of 300 Mt being the “normal” amount, In year one, they might release 270 Mt worth of permits. Due to demand, they sell for $10 a permit, so thats $2.7 billion dollars. Next year, they might only make available 260 Mt of permits. With less permits on the market, competition will be fiercer, so they might end up selling for $11 a permit. Thats $2.86 billion dollars – less carbon has been emitted, and the government’s revenue has increased!

(Of course, thats purely a hypothetical to show that the Government doesn’t have a disincentive to reduce the number of permits – the actual value of the permits won’t be clear until some models are released).

This also means that buyback is not a problem. As permits get “used up” as they are activated, all the Government needs to do is issue less and less each year. (I should mention that a “tuning” possibility with an ETS is the lifetime of a permit. That is, if you don’t “use it up”, how long does it last? There are some effects of this that are interesting to think through, positive and negative – I won’t get into it for now.)

If I’ve read your comment right, I think this point might answer a few of your concerns with an ETS. I still have a few concerns of my own, but they mostly rest with the detail of what is eventually implemented, rather than the general concept.

I did mix up Australia’s particular ETS and the general concepts, which was sloppy of me. In general ETS are a bad idea, for reasons I wrote here and then more neatly in a recent blog entry (basically just what I said here fleshed out a bit). But the Aussie implementation is particularly bad. It’s looking like it’ll have so many exceptions and waivers that nothing useful will come of it. But really we have to see it to judge it.

Speaking generally of ETS: it’s true that if they make the permits scarce then they’ll get a high price for them. But in this it’s like a product of a business, you can go high volume, low price, and low volume, high price. The fact that Porsche exists in the same world as Lada shows that there is no single best solution for maximising profit. The difference is that a business will be influenced by production cost – they need to have the price at least one cent per unit more than the cost of making it – but government permits have zero production cost. So they can sell them at any price above $0 each and still turn a profit. They don’t really have an incentive to limit production when production cost is zilch.

The ideal in maximising profit in such a case will probably be to initially produce just short of demand, and then each year issue some more, again just short of demand. So if they assess that our total permit-affected emissions are (say) 300Mt and likely to increase at 10Mt annually, then they should issue 270Mt today and then another 7Mt annually.

You didn’t address the issue of the buyback. If we’re to reduce emissions, then over the years the government will have to buy the permits back. This will increase demand and price, so that the government will have to acquire money from elsewhere, raising other taxes. If they’re unwilling to do that (as they usually are in the first and third years of any particular three year term of government) then we see the total permits issued unchanged.

In this I’m reminded of the big sell-off of state-owned enterprises we had in the 1990s. Yes, we got a lot of money from it, but after that what? That’s why they brought in all that legalised gambling, and started subsidising mining even more – to bring in revenue to replace the revenue they used to get from the state-owned enterprises. So after the big cash burst of the initial permit-issuing runs out, what then?

What changes consumption/emission is a change in taxes. When you lower taxes/prices, people raise prices of goods to suck up the spare cash, and a new balance is found. When you raise taxes/prices, people drop the prices of goods, or people change their spending (eg with the real estate boom, people move to cheaper outer suburbs, thus spending less on housing, more on transport). That’s why when theyy brought in the GST spending dropped for several months and then went up again – people adjusted. So with a carbon tax, you’d want to start small and then raise it every year or two.

It’s like going to the gym, you have to be constantly under a little bit of strain to build your muscles. If you keep people’s carbon spending constantly under a little bit of strain, then they’ll build their carbon efficiency.

Incidentally, it’s with this sort of thing in mind that I developed my carbon accounting system.

I understand your point, but I think your concerns are more to do with how Australia’s ETS is likely to be implemented, rather than the general concept of ETS’s themselves?

As I understand it, there is nothing preventing an ETS from covering more than fossil fuels, just like there is nothing preventing a carbon tax only being applied to a specific industry rather than the whole economy. It comes down to economic thinking and, inevitably, political considerations.

I also think that Government won’t necessarily be discouraged from reducing permits _because_ its an auction system. The less permits the Government releases, the more valuable they will be because industry will be so keen to bid for them. This should have the effect of a) keeping revenue for the government fairly equal, regardless of permits offered (within reason, obviously!) and b) providing greater and greater incentive for companies to reduce their emissions as the permits become more valuable.

I have to admit, I haven’t seen any modelling on this. The one thing that is painfully clear is that the devil will be in the eventual detail. Roll on the release of the Green Paper!

Your point on the carbon tax encouraging government to raise carbon prices is a good one which I hadn’t thought of – market forces combined with Government’s natural urge to maintain its tax base could work together to drive down emissions! I like it! Of course, the same could be said for the GST (a tax on consumption) – because of the low rate of the GST, I don’t believe it has had too much effect on lowering consumption and it would probably be a political nightmare to try and raise it. Again, I suspect the devil is in the detail of the implementation.